If conversation were currency, freight rate derivatives would be trading on a rich exchange. But when a small U.S. freight forwarder, TBB Logistics, started offering derivatives as a hedge to its customers on U.S. import routes this year, the company became one of only a handful of operators to put the instrument in its shipping portfolio.
Backers of derivatives got more support this month when Drewry Shipping Consultants said it was teaming with Cleartrade Exchange to offer a new hedging instrument, raising the decibel level on what some insist will become a critical tool in international shipping.
“Despite the very slow take-up of derivatives in the year since they were introduced, we thought that we could foster development of this fledgling hedging tool if we could develop a different and better index,” said Philip Damas, Drewry’s director of liner shipping and supply chains.
And supporters of derivatives, whether the Drewry model or the older instrument built on the Shanghai Shipping Exchange’s rate measures, say time is on their side.
Sidebar: SSE Defends Methods, Transparency .
It took owners of dry bulk ships and tankers a decade to start using freight forward agreements to hedge against losses on fluctuating freight rates after they have contracted for cargo transport of their commodities. Such contracts typically are worked out far in advance of the actual transport, but the low value of the bulk commodities means the stakes on freight rate movements are high.
But it took a decade for the trading volume of the futures contracts indexed to the Baltic Dry Index to build enough liquidity to become attractive to investors and speculators on global futures markets.
Now, dry bulk shipowners and shippers routinely hedge their contracts against rate volatility by trading derivatives on several global futures exchanges. The contracts traded on dry cargo alone cover shipments with more than twice the actual volume of dry cargo shipped globally every year and run into the hundreds of billions of dollars.
A year-and-a-half after they were rolled out on a wide level, derivatives based on the SSE’s container freight rate indexes, offered in partnership with Morgan Stanley and Clarksons Securities, have not attracted much volume on global futures markets.
The Drewry-Cleartrade instrument is based on freight rates on 11 major east-west trade lanes the backers say can be used to manage freight rate risk. The “World Container Index Assessed by Drewry” will report individual market prices on major east-west container shipping routes collected by Drewry analysts. Initially, prices for 11 individual routes and a composite index will be reported each week. These will cover trade in both directions between Asia, North America and Europe.
Cleartrade, a Singapore-based electronic exchange for freight and commodity derivatives, thinks the key to the future of the WCI is that it includes indices for rates on the backhaul — or export — legs of services to Europe and North America.
“It has the U.S. and European export markets in there, which could be bigger drivers of liquidity,” said Richard Heath, general manager of WCI Marketing Services, the joint venture between Drewry and Cleartrade. “We’re aiming at a different market, the grain traders, agri-bulk shippers, scrap metal exporters and wastepaper shippers, who own the cargo and are very much more used to using financial derivatives to manage their risk.”
Although the goods typically are lower in value than U.S. and European import products, such commodity exports account for by far the largest share of U.S. and European containerized export volume.
Clarksons Securities launched the first and, until now, only container rate derivative in January 2010, the Container Freight Swap Agreement, which trades on the Shanghai Shipping Exchange.
Clarksons targeted container carriers as the market for these derivatives. It has been slow to build liquidity. Only a few, mainly smaller, carriers and some forwarders, mainly on U.S. trade lanes, are trading the instrument, which has an average weekly volume of contracts covering about 400 20-foot equivalent units.
“The big lines are very negative, but I think the market is changing more quickly than people think, because the rates for container shipping are being set more by the spot market in many ways,” said Brian Nixon, executive director of commodities at Morgan Stanley in London, which trades the swap agreement.
“From what I can see, freight forwarders and shippers are basically working through the spot markets for their rates anyway because of the short visibility of the rates being handed out by the lines,” he said.
Chilean carrier CSAV is trading the CFSA as are some of the smaller Asian carriers and one Greek container ship owner.
Nixon, chairman of the Container Freight Derivatives Association in London, said he believes in five years, container swaps could amount to 10 percent of the global container market.
Morgan Stanley plans to trade the new Drewry WCI-based derivative when it becomes available in the next month or so when it gets the approval process in place.
Nixon said it will take some time for the market to work out its view of the WTI, but he says a fair and transparent index would make the derivative successful. “The indices for the backhaul routes will encourage a lot of the commodity players to get involved,” he said.
TBB Global Logistics, a non-vessel-operating common carrier and forwarder based in York County, Pa., entered into an agreement with ICAP Logistics to offer the swap agreements, which are indexed to the SSE’s Shanghai Containerized Freight Index.
“Due to the recent volatility of shipping markets and macroeconomic uncertainty … CFSAs create opportunities for many businesses that were previously unable to take a more active approach to risk management in the ocean container market,” said Sam Polakoff, president and co-owner of TBB. “Importers with low-margin product will find CFSAs an intriguing methodology to deliver promised bottom-line results to company shareholders.”
The large container lines have resisted hedging their freight rates, even as spot rates on the main east-west container trade lanes from Asia to Europe and North America have mainly declined since the start of the third quarter of 2010.
Maersk Line CEO Eivind Kolding summed up what looks like general hostility last year, calling them “a casino for freight rates.”
APL and Zim Integrated Shipping Services also have criticized container rate derivatives, saying they will increase price volatility and will not benefit carriers or shippers. And other carriers have dismissed the idea with barely disguised disdain.
“We are not interested in this market,” said Nicolas Sartini, senior vice president for Asia-Europe liner trade at CMA CGM, calling it a “speculative tool … that is not demand driven but supply driven.”
Speaking at industry conference last month in London, he took after the SSE, in particular. “Whoever heard of the Shanghai Shipping Exchange? It is made up of small Chinese forwarders who are active only in one small sector of the market,” he said.
“The factors they are looking at are not the correct ones. They are working from the most volatile part of the business. They don’t take into account the long-term contracts, the overall environment of the business,” Sartini said of the SCFI-based derivative.
But to Drewry and others, the criticism of the method doesn’t necessarily mean the derivatives concept is fatally flawed.
“There is no doubt that there is considerable cultural resistance in the carrier camp to this kind of financial tool,” Damas said. “The carriers spend their entire lifetime trying to control the market, but this type of product is the opposite. It means that carriers will have to follow the market and all they can do is to hedge it or not hedge it.”
And there is no doubt that market has been exceptionally volatile in recent years.
Spot rates measured by Drewry’s weekly Container Rate Benchmark soared more than 100 percent year-over-year for several weeks in 2010 heading into the peak shipping season, including a few weeks when they were more than triple the year-earlier levels. This year, Drewry’s eastbound trans-Pacific measure in early May was 30 percent below the level of last August.
The SCFI has followed a similar track.
Damas said the freight rate derivatives have become more valuable because carriers in deregulated markets no longer can send signals on rate guidelines. “Now it’s entirely driven by the market,” he said.
Drewry decided to take the plunge this year after Cleartrade convinced the company there was an enormous potential market for derivatives.
Drewry already provided container rate benchmarks on some 300 different trade routes, but they will remain separate from the new indexes the London-based consulting and research company will compile on 11 east-west routes. The new indexes are different from the benchmarks in that they will be audited by an independent third-party financial auditor that has not yet been selected.
“So the requirements will be higher than what we have been doing traditionally,” Damas said. “You have to demonstrate there’s no funny business.”
Damas thinks the development of the market for indexed containers freight rate derivatives will follow the pattern that evolved over a decade in the dry bulk and tanker sector. “If you go back 10 years, all the dry bulk carriers and all the tankers were dead set against it,” Damas said, “and now they have accepted it.”
Contact Peter T. Leach at firstname.lastname@example.org.